Friday, June 29, 2012

Here’s The ProblemOver the past ten years the Portuguese economy has been virtuallystationery. The problem is not, note, simply a Euro one, since the declinestarted in the mid 1990s, and has never been reversed.

Here’s another way of looking at the same issue. Portuguese GDP rose rapidlyin the 1990s, and then much more slowly in the first decade of the 21stcentury. Structural reforms undertaken as part of the bailout programme may help a little, but there is clear something more going on here than simply a small, temporary loss of growth dynamic. Could it be that as populations get older growth gets slower, or even turns negative?

In this presentation I will argue that• The most recent crisis was not an arbitrary phenomenon• There is an underlying process we need to understand• Europe’s debt crisis is now entering a decisive phase.• Unresolved issues will leave a legacy. One which could weighdown any recovery and lead to more serious problems in thefuture. In particular: a) The Existence of a Debt Overhang b) The Impact of Ageing and Declining Populations

So What Was The Global Crisis All About? It was all about debt, and about how heavily indebted societies were going to be able to claw their way back to growth.The Key Points To Grasp – This Process Is Structural, Not Cyclical,and it is a Developed Economy Crisis, Not Simply A Euro One

So Just Why Was There So Much Debt?• Badly Structured Financial Products?• Poor Regulation?• Or Was There Something Else Going On?

Case Study: The Eurozone Here is a key part of the puzzle. During the first 10 years of the Euro some European countries borrowed heavily, while others lent. As a result Spain’s households contracted a lot of debt. Yet German households didn’t. Why this difference?

One Conventional Account The “one size fits all” monetary policy didn’t work. Spain had negative interest rates during the key years of the housing boom.But that still leaves us with a question: why didn’t it work?

Credit Driven Private Consumption Booms Why do some countries have these while others don’t? In fact both Spain and Germany have had these.The only real difference is in theTiming.Germany 1992 – 1999Spain 2000 - 2008

Current Account Blues Germany didn’t always run a current account surplus. All through the 1990s the current account was in deficit. And Spain won’t always run a current account deficit, even if that seems hard to believe right now.

The Key 25 to 49 Age Group This group peaked in Germany – as a % of total population around the turn of the century.And in Spain it peakedtowards the end of thefirst decade of thiscentury.

Could Something As Simple As Median Population Age Help Us Understand? Ours is an age of rapidly ageing societies. What is so modern about our current situation is not the ageing itself, but its velocity, and its global extension.Does median population agehave something to do withgrowth? Most professionaleconomists deny this to be thecase, but to many noneconomists the connection isintuitively obvious.

Population Ageing – A Unique Historical ChallengeThe economic and social implications of the ageingprocess are going to be profound.• the process is seemingly irreversible.• No other single force is likely to play such animportant role in shaping the future of nationaleconomic health, public finances, and policymaking overthe coming decade Strangely, the issue receives only a fraction of the attention that has been devoted to global climate change, even though, arguably, ageing is a problem our social and political systems are, in principle, much better equipped to deal with.

As far as we are able to understand the issue at thispoint, population ageing will have major economicimpacts and these can be categorised under four mainheadings:i) ageing will affect the size of the working age population, andwith this the level of trend economic growth in one country afteranotherii) ageing will affect patterns of national saving and borrowing, andwith these the directions and magnitudes of global capital flows iii) through the saving and borrowing path the process caninfluence values of key assets like housing and equities iv) through changes in the dependency ratio, ageing will influencepressure on global sovereign debt, producing significant changes inranking as between developed and emerging economies.

While population ageing is universal the short term impactwill be much more localised. The pace of aging variesgreatly across countries and regions.The effects of the process are expected to be mostpronounced in those countries that remained complacentin the face of ultra-low fertility rates (total fertility rates of1.5 and under), which in effect means Japan, the Germanspeaking countries and much of Southern and EasternEurope.

Another way of looking at these demographic changes is interms of the dependency ratio, which can be defined in anumber of different ways depending on the problem beingaddressed. The elderly dependency ratio in Germany is rising much more rapidly than it is in either the UK or France. It is really hard for me to believe that this profound difference won’t be reflected in national wealth production or GDP per capita.

Importance Of The Prime Age GroupsThe key groups are prime Estimates of the exact agesavers, prime borrowers, and extension of the differentprime productive workers. groups vary, but 25-40 wouldWhere these actual age be a good rule of thumbbrackets lie, and the extent to measure of the borrowingwhich they may overlap, is still range, 40 to 55 for the peaka subject of some controversy, savers, and 35 to 50 for the One of the key points to grasp, is that prime age workers. the proportion the population which is to be found in one of the ‘prime’ age Beyond this, the question is an groups at a given moment in time, is empirical one of measuring absolutely critical, and much more and testing to determine more important for understanding the processes at work than the mere size precise boundaries and of the working age population. frontiers.

Life Cycle EffectsThere is a generally accepted wisdom in academic work knownas the “life cycle hypothesis” (Modigliani). This suggests that thepopulation’s financial behaviour changes depending on age. Interms of adult life, those in their twenties and early thirties tendto be net borrowers as they are relatively low earners at thesame time as they look to buy housing, expensive durables andfund their burgeoning families. At some point around middle-age this group then tends to move from being net borrowers tonet investors as they move into their economic prime andaccumulate financial assets to hopefully fund their retirement.As they approach retirement this group then start to shed thefinancial assets they’ve been accumulating to fund theirnonworking days.

Case Study PortugalPortugal, like all Europeansocieties is ageing quiterapidly And the main reason for this is, of course, long term very low fertility

Unique Portuguese Features Portugal in some ways resembles East European societies. The country lost population during the EU “coupling” years, and the phenomenon has left a lasting scar on the economy and the society.Portugal went from being anet emigration society tobeing a net immigration one.But now with the latest crisisthe direction of migrant flowsis once more reversing, in away which presents veryserious problems for a lowfertility society.

Portuguese Living Standards HaveStagnated Over The Last DecadeFar from Euro membership being an unmitigated success for Portugal, the countryhas seen a serious lack of growth in living standards and a loss of relative positionin the “Euro league”. To take one example, while up to the outbreak of the crisisliving standards in Slovenia steadily rose towards the EU average, Portugal’srelative position fell back and then stagnated.

As Elsewhere The Current Crisis Is Largely About Debt Portugal ‘s economy may not have grown, but the country has accumulated a large mountain of both private and public sector debt over the last decade.There is about 250 billion eurosin private sector debt and 170billion euros in public sectordebt. Portuguese GDP is around160 billion euros, so total debt toGDP is around 260%. Withoutgrowth this is clearly notsustainable.

Portugal has now had an initial 78 billion eurobailout and is in a deficit correction programme

And TheTroika Consistently Give The Country Glowing Reports

Along With The Deficit Even The Bond Yields Are Coming Down

So Where’s The Problem?Well, the economy is in deep recession.The IMF expect the economy tocontract by 3.3% in 2012, and returnto timid growth in 2013 (0.3%). Thereare strong downside risks to the 2013forecast, and it is not improbable theeconomy will once more contract. Unemployment is now rising sharply. Apart from the social distress caused this surge in unemployment is having two consequences. Deficit targets will not be met, and the young and educated are leaving the national ship.

The First Consequence - A Second Bailout Looks Very Likely Pedro Passos Coelho The connection between unemployment and the second bailout is that unemployment is producing a deficit in the social security fund. So the country may need a relaxation in the bailout programme fiscal targets, and the renegotiation of these could well provide the context for a full second bailout.
In Addition Young Educated People Are Increasingly Leaving Why is this a problem? Well think of the ageing society and growth problems I mentioned earlier. In fact economies exist in real historical time and not the ideal state space postulated by neoclassical economics. They are path dependent entitites and opportunities lost now have permanent consequences. Of course, in Europe we need labour market flexibility, but we also need a common Treasury to make pensions sustainable.

And The Banking System Remains Overdependent On The ECB

So when Will The Second Bailout Happen?Likely date September. Why?Well Portugal is programmedto return to the markets tofinance bonds in September2013, and the IMF has a“financing guaranteed 12months ahead” rule. And How Much Will It Cost? More than likely in the region of 50 billion euros 24.2 billion for financing in 2013/14, plus another 26.9 billion euros for 2015. And then something to allow for the worsening economic scenario and the relaxed deficit conditions.

PSI Unlikely At This Point The markets have pulled back since earlier this year, and are now not pricing in PSI. But Portuguese debt is balanced on a knife edge , and PSI in the longer term is not improbable.

Where Does All That Leave Us? In a One Step Forward.... or several hundred billion steps back situationMaybe world leadershave been exaggeratingthe time scale, but therisks are real

What Can Be Done? a) Shotgun Wedding b) Full Banking Union c) Common Fiscal Treasury d) Central Bank able to act like the BoJ, the BoE and the US Federal Reserve e) Less austerity and common finance to support the various economies while much needed structural reforms are undertaken. This is just not doable say the critics. Well then, think about the alternatives for just 5 minutes and maybe you will change your minds.

No Easy Answers At This PointEffectively I am suggestingturning Europe into asecond Japan. But Japan’spublic debt path is not longterm sustainable. Japancouldn’t exit the Yen couldit? Basically we are faced with a complex set of problems which were never foreseen in economic theory. We don’t live in a perfect world. Angela merkel is wrong on austerity, but is right that in the longer run debt needs to be sustainable and our economies stable, and not running on “funny money” in a way which will end in tears.

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Edward Hugh

Born in Liverpool Edward Hugh is a macroeconomist of British origin who has lived in Catalonia for over 25 years. For 20 of those years he lived and worked in Barcelona, but since 2010 he has been living in a small village near the town of Figueres.

Hugh, who studied economics at the LSE in the late sixties before going on to do Masters and Doctoral studies in Manchester, is an expert on the impact of demographic change and migratory processes on economic growth.

His work came to be known to a wider international public following the publication of a New York Times article highlighting his anticipation of the Euro Area crisis.

Since the start of the crisis Hugh has become a reference point for the international press in relation to the difficult economic situation in Spain.

He is an active blogger, and regular contributor to social network platforms like Twitter and Facebook where he is widely followed. He has no political involevment of any kind, and is proud of his reputation as an independent analyst-

In Spain he has recently published a book on the Spanish economy (¿Adios a la crisis?, Deusto 2014), and is a frequent contributor to the Barcelona press.

He is currently working on his next book - No Growth Societies - which will be written and published in English. He is also a regular speaker and participant in Forums and Economic Seminars, within and without Spain, a vocation which has taken him across Europe and the Middle East, from Brussels and Vienna, to Riga and Bergen, to Doha and Tel Aviv.